There really is no other way to say it: the global economy is now on a debt binge the likes of which we have never seen before. But consumers are no longer at the wheel; instead, governments are now hell bent on protecting consumers (and the markets they help make) from the consequences of their own actions.
We’re all—that’s Europe, the U.S., and even Japan—now attempting to paper over our bad debts, not just in mortgages, but even sovereign debt. News of the $1 trillion EU bailout super-fund this past weekend really is the nuclear option, even if here at home the crisis in Greece seems so far away.
The truth is that we’re far closer to our European neighbors than you might think. First of all, the IMF is funding part of the bailout here, roughly $285 billion or so using back-of-the-napkin math; and the U.S. contributes 17 percent of IMF’s funding. So U.S. taxpayers are going to foot the bill here for $50 billion of so of profligate spending outside the States—as if our own spending problems weren’t already problematic enough.
Also, in conjunction with the EU bailout, the Fed simultaneously re-opened the USD swap line to the Europeans this past weekend. Consider it quantitative easing on a global scale. What this means is that we’re firing up the printing presses again, so to speak, allowing dollars to be sold for Euros in the market under the guise of “ensuring market liquidity.”
Why bolster the Euro at the potential expense of our own currency? The reasons for this aren’t really rocket science. Beyond the many billions of dollars of direct exposure our banking system has to the eurozone, our European trading partners represent some of the single largest markets for U.S. exports. A weak Euro would slaughter U.S. exports at the altar of austerity and hit bank earnings, precisely when we need strong U.S. exports and expanding bank balance sheets to support our own fragile economic recovery.
So, beyond the vast sums of money we’ve already pumped into our own economy to stanch off the effects of a debt crisis, we’re now sending the almighty dollar to flood global currency markets in an “all-in” effort to stanch off worldwide credit deflation and the systemic effects stemming from it. It’s reflation on a massive scale.
A world that consists only of extremes?
Only time will tell if the ultimate solution to a debt crisis is to pile on even more debt. I’m firmly in the camp that says it isn’t ultimately possible to borrow your way to prosperity. Regardless of what I think, however, it’s clear that we’re all Greek now—and we’re going along for this ride whether we like it or not.
In the short run, I think U.S. mortgages benefit from a flight to quality, as rates remain low thanks to strong demand for Treasuries. Longer term, however, I’m very concerned—and the “solution” to the Greek debt crisis (read: more debt) underscores the source of my concerns here.
I’ll let Broyhill’s Chris Pavese explain:

The “choking point” of rising rates on the economy has become lower and lower over time. In other words, greater and greater levels of debt act as larger and larger speed bumps for economic growth. Put simply, with an ever increasing weight of debt on our shoulders it takes successively smaller hiccups in yields to break the economy’s back. In 1989, when rates rose to 9.5%, they popped the commercial real estate bubble and caused the S&L crisis. In 1999, the tech bubble busted as rates approached 6.5%. And in June of 2006, interest rates at 5.25% triggered a collapse of the residential property market and brought about the Great Recession.

Given the massive-and-still-expanding debt load now being carried by our own government, it stands to reason that it won’t take much in the way of increased rates to send bond markets reeling again.
Supporting this idea, financial market vet Alan Boyce at Absalon, a joint venture between the Danish financial system and George Soros, suggested to me last week that the level of embedded duration currently lurking in US mortgage bond markets is far more than most people think. (Duration is a measure of interest rate sensitivity, for the uninitiated.)
And while we’re at it, consider that analysts at JP Morgan Chase & Co. [stock JPM][/stock] have estimated that adjustable-rate mortgage resets are looming (again)—to the tune of $418 billion in the next three years, with $182 billion of resets hitting in 2011 alone, using forward interest rates. That’s nearly 1 million loans, and these resets are estimated to drive payment shocks ranging from an average of 13 to 34 percent, depending on year.
With Bernanke and the Fed now making it amply clear over this past weekend that they’re willing to sacrifice the value of the dollar if need be, one has to at least wonder how long deflation will ultimately remain the predominant concern in financial markets. One might even begin to think Bernanke could be more right than even he knows: if the entire world is in a liquidity trap, maybe the solution really is quantitative easing on a grand, global, and coordinated scale.
For our sakes, however, it seems best to pin our hopes on only moderate success. Because too much success here means living a world where only extremes would seem to exist: we are either fighting against the pull of a liquidity trap and its associated death-spiral of deflation, or we are fueling the very end of the fiat currency system the world over and setting ourselves up for hyperinflation. Neither is a very pleasant thought.
Paul Jackson is the publisher of HousingWire Magazine and Housingwire.com. Follow him on Twitter: @pjackson

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